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A brief guide to how SAFE monitors and regulates PRC companies and their cross-border trading activities

1. Introduction

The State Administration of Foreign Exchange (SAFE) is the authority in the People’s Republic of China (PRC) responsible for administering the country’s foreign exchange reserves and regulating the cross-border flow of funds between the PRC and other countries or regions.

Over the past year we have seen an increasing number of multinational commodities companies’ Chinese subsidiaries being subject to various measures taken by SAFE, for example, being subject to an onsite inspection by SAFE or being downgraded by SAFE from a Class A company to a Class B company. What does such SAFE action mean? How serious is the situation?

The purpose of this note is to help you to understand the various measures that SAFE takes to monitor and regulate PRC companies and their cross-border trading activities. The scope of this note is limited to administrative measures that may be taken by SAFE and so does not cover any civil or criminal liabilities that a company may incur due to violation of PRC law or regulations.

2. Trading Company List

For any company that wishes to carry out cross-border trading activities, after the company obtains its business licence, the first thing to do is to register with the local branch of SAFE and become a member of the List of Companies which Conduct Trading Activities and Pay and Receive Foreign Exchange (Trading Company List).

3. Class A, Class B and Class C

SAFE classifies each company on the Trading Company List as a Class A, Class B or Class C company. Class A is the highest ranking; it means the company in question has a good record in complying with SAFE regulations. Normally, a newly established company will start with Class A. If a company violates SAFE regulations, depending on the seriousness of such violation, it may be downgraded to a Class B or Class C company.

Class A companies enjoy simplified procedures when processing cross-border payments. Under most circumstances, banks are allowed to process cross-border payments by Class A companies directly, i.e., without any involvement of SAFE.

If a company is classified as or downgraded to a Class B company, it will be subject to more complicated procedures when processing cross-border payments; for example, banks will be required to check each proposed payment against the details of the goods to be imported or exported. For cross-border payments which are above a certain amount, the company will be required to seek prior permission from SAFE. Also, the company will be prohibited from conducting any transit trade or entering into any import or export transaction which has a deferred payment exceeding 90 days.

If a company is classified as or downgraded to a Class C company, it will be subject to additional restrictions on top of those that apply to Class B companies. For example, a Class C company will be required to seek prior permission from SAFE for each cross-border payment to be made by the company. Also, the company will be prohibited from opening any letter of credit with a term exceeding 90 days. Furthermore, if it has any overseas bank account used for cross-border trading activities, the company will be ordered to close the account within 30 days of becoming a Class C company and remit all the money in the account back to China.

Becoming a Class B or a Class C company is not a life sentence. If a company is classified as or downgraded to a Class B or a Class C company, its status will be reviewed after 12 months. If during this 12-month period, the company’s compliance with SAFE regulations is satisfactory to SAFE, it may regain its original classification or be upgraded to a Class A company.

4. Offsite Inspection

SAFE checks the overall amount of a company’s cross-border payments against the overall amount of goods imported or exported on a regular basis by the same company within a particular period. Such exercise is called offsite inspection.

An offsite inspection looks at the data within a particular period as a whole and does not target individual transactions. SAFE will look for consistency (or the lack of it) between the payment data and the import and export data.

If the offsite inspection reveals any irregular or suspicious cross-border transactions, SAFE may decide either to conduct an onsite inspection of the company in question (see section 5 below) or issue a risk warning letter to the company (see section 6 below).

5. Onsite Inspection

SAFE may take the following actions during an onsite inspection:

demand that the company hand over relevant transaction documents;

interview the senior management of the company; and/or

visit the premises of the company to search for and photocopy any relevant materials.

Before carrying out an onsite inspection, SAFE will issue an Onsite Inspection Notice to the company. The company will be required to acknowledge receipt of the notice within three days of the date of the notice and provide all the documents required by SAFE within 10 days of the date of the notice.

The result of an onsite inspection will be one of the following:

no further action is taken by SAFE, which means SAFE finds no violation of SAFE regulations;

the company is downgraded to a Class B company, which means SAFE discovers relatively minor violation of SAFE regulations;

the company is downgraded to a Class C company, which means SAFE discovers major violation of SAFE regulations; or

the company is removed from the Trading Company List, which means the company loses its qualification to carry out cross-border trading activities.

6. Risk Warning Letter

Compared to onsite inspection, a risk warning letter is a less severe measure taken by SAFE. After receiving a risk warning letter from SAFE, the company will be required to provide a written response to SAFE’s queries within 10 days of the date of the letter. If the company is unable to provide a satisfactory response to SAFE within the prescribed time, it may be downgraded to a Class B company.

7. Conclusion

Onsite inspection by SAFE can be quite frightening, especially when the senior management of the company is summoned by SAFE to its offices for interview. That said, being downgraded to a Class B company is not the end of the world: by and large, the affected company would be able to carry on the majority of its normal business activities.

Multinational commodities companies which have subsidiaries in China need to get familiar with these SAFE actions, so that they know what to expect when they next get a call or letter from SAFE.